Problem 22-17 Cost Centers, Profit Centers, Decentralization, Transfer Prices.

Given:
Fenster Corporation manufacturers windows with wood and metal frames. Fenster has three departments: Glass,
Wood, and Metal. The Glass Department makes the window glass and sends it to either the Wood or Metal Department
where the glass is framed. The window is then sold. Upper management sets the production schedules for the three
departments and evaluates them on output quantity, cost variances, and production quality.
1.

Are the three departments cost centers, revenue centers, or profit centers?
Responsibility Center: A part, a segment, or a subunit of an organization whose manager is accountable for a
specified set of activities.
Cost Center: a responsibility center where the manager is accountable for costs only.
Revenue Center: a responsibility center where the manager is accountable for revenues only.
Profit Center: a responsibility center where the manager is accountable for revenues and costs.
Investment Center: a responsibility center where the manager is accountable for investments, revenues and costs.
The Glass, Wood, and Metal departments are all cost centers. They are evaluated as cost centers based on
output and variances from expected costs.

2.

Are the three departments centralized or decentralized?

Centralized: Upper management sets their production schedule

3.

Can a centralized department be a profit center? Why or why not?

Yes. Centralization relates to the degree of autonomy that a department has for decision making. This concept is
independent of the type of responsibility center used to evaluate performance. For example, the Glass department
could be a profit center if upper management sets a transfer price for the glass transferred from the glass to the
Wood and Metal departments. A department may be organized as a profit center but has little decision-making
authority. Such a department would be a centralized department.

4.

Suppose the upper management of Fenster Corporation decides to let the three departments set their
own production schedules, buy and sell products in the external market, and have Wood and Metal
Departments negotiate with the Glass Department for the glass panes using a transfer price.
a.
Will this change your answers to requirements 1 and 2?
With these changes, Fenster will be moving toward a more decentralized environment because each
department will have more local decision-making authority, such as the ability to set its own production
schedule, buy and sell products in the external market, and negotiate transfer prices.
These changes make all three departments profit centers because the managers of each department are
responsible for both costs and revenues.
b.

How would you recommend upper management evaluate the three departments if this change
is made?
Upper management should evaluate the three departments as profit centers because profits would be a
good indicator of how well each department is doing.

Problem 22-19 Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimiz

Tech Friendly Computer, Inc., with headquarters in San Francisco, manufactures and sells a desktop computer. Tech
three divisions, each of which is located in a different country.
a. China division -- manufacturers memory devices and keyboards
b. South Korea division -- assembles desktop computers using locally manufactured parts, along with memory de
the keyboards from China division.
c. U.S. division -- packages and distributes desktop computers

The three divisions are evaluated as profit centers. The costs for work done in each division for a single desktop com
as follows:
China Division
South Korea Div.
Mfg. Process
Memory devices and keyboards
Assembles computers using
internally manufactured parts
and memory devices and
keyboards from the China Div.
Currency
External Selling Price
Variable cost
Fixed
Income tax rate
Current Exchange rates
Conversion to U.S. Currency
Currency
Selling Price
Variable cost
Fixed
Income tax rate
Transfer price Method
Market Price
200% of Full Cost
350% of Variable Cost

Yuan
4,500
900
1,980
40%
9

memory/keyboards
yuan
yuan
9 yuan = $1 dollar

U.S Dollar
$500 memory/keyboards
100
220
40%
$500
640
350

China to South Korea

Won
1,340,000
350,000
470,000
20%
1,000

U.S. Dollar
$1,340
350
470
20%
$1,340
2,920
2,450

1. Calculate the after-tax operating income per unit earned by each div. under the following transfer-pricing methods:
China Division
Selling Price (TP)
Deduct:
VC per unit
FC per unit
Divisional Operating Inc.
Income Tax at 40%
Divisional NI per unit

Market Price
$500

200% of Full Cost

$640

(100)
(220)
$180
72
$108

(100)
(220)
$320
128
$192

South Korea Div.

Selling Price (TP)
Deduct:
Trans-in from China
VC per unit
FC per unit

Market Price
$1,340

200% of Full Cost

$2,920

(500)
(350)
(470)

(640)
(350)
(470)

$2,210

Divisional Operating Inc.

Income Tax at 20%
Divisional NI per unit
U.S. Division
Selling Price (TP)
Deduct:
Trans-in from South K.
VC per unit
FC per unit
Divisional Operating Inc.
Income Tax at 30%
Divisional NI per unit

$20
4
$16

$1,460
292
$1,168

Market Price
$3,800

200% of Full Cost

$3,800

(1,340)
(125)
(325)
$2,010
603
$1,407

(2,920)
(125)
(325)
$430
129
$301

2. Which transfer-pricing method(s) will maximize the net income per unit of User-Friendly desktop computer?

China Division
South Korea Div.
U.S. Division
Total

Market Price
$108
16
1,407
$1,531

200% of Full Cost

$192
$1,168
$301
$1,661

User Friendly will maximize its NI by using the 350% of variable costs, transfer-pricing method.

ng methods, global income tax minimization

s and sells a desktop computer. Tech Friendly has

ufactured parts, along with memory devices and

each division for a single desktop computer are

bles computers using

lly manufactured parts
emory devices and
rds from the China Div.

computer
won
won
1,000 Won = $1

computer

U.S. Division
Packages and distributes
desktop computers

U.S. Dollar
3,800 computer
125 dollar
325 dollar
30%
1

U.S. Dollar
$3,800 computer
125
325
30%

South Korea to U.S.

he following transfer-pricing methods:

350% of VC
$350

$2,210

(100)
(220)
$30
12
$18
350% of VC
$2,450
(350)
(350)
(470)

$2,210

$1,280
256
$1,024
350% of VC
$3,800
(2,450)
(125)
(325)
$900
$270
$630

ser-Friendly desktop computer?

fer-pricing method.

350% of VC
$18
$1,024
$630
$1,672

Problem 22-25 Transfer-pricing dispute

The Allison-Chambers Corporation, manufacturer of tractors and other heavy farm
equipment, is organized along decentralized product lines, with each manufacturing
division operating as a separate profit center. Each division manager has been delegated
full authority on all decisions involving the sale of that division's output both to outsiders
and to other divisions of Allison-Chambers. Division C has in the past always purchased
its requirement of a particular tractor-engine component from Division A. However, when
informed that Division A is increasing its selling price to $150, Division C's manager decides
to purchase the engine component from external suppliers.
Division C can purchase the component for $135 per unit in the open market. Division A
insists that, because of the recent installation of some highly specialized equipment and the
resulting high depreciation charges, it will not be able to earn an adequate return on its
investment unless it raises its price. Division A's manager appeals to top management of
Allison-Chambers for support in the dispute with Division C and supplies the following
operating data:
C's annual purchase of the tractor-engine component
A's variable cost/unit of the tractor-engine component
A's fixed cost per unit of the tractor-engine component

1,000 units
$120
$20

Allison-Chambers

Division A

Outside Supplier

Division C
1,000 units
tractor-engine component

SP = $150

???

SP =$135

VC = $120
FC = $20
1. Assume that there are no alternative uses for internal facilities of Division A. Determine
whether the company as a whole will benefit if Division C purchases the component from
external suppliers for $135 per unit. What should the transfer price for the component be
set at so that division managers acting in their own divisions' best interests take actions
that are in the best interest of the company as a whole?
Unit cost of buying the component from outside
Avoidable cost of manufacturing the component in Division A
Unit disadvantage of buying the component from outside
Total disadvantage of buying the 1,000 components from outside

($135)
$120
($15)
($15,000)

Transfer price:
Minimum that Division A (seller) would accept
Incremental costs of making component
Maximum that Division C (buyer) would accept
Cost of buying the component externally
Therefore, any transfer price between $120 and $135 per unit will achieve
goal congruence. That is, division managers acting in their own best interest

$120
$135

will take actions that are in the best interests of the company as a whole.
2. Assume that internal facilities of Division A would not otherwise be idle. By not
producing the 1,000 units for Division C, Division A's equipment and other facilities
would be used for other production operations that would result in annual cashoperating savings of $18,000. Should Division C purchase the component from
the outside source?
Total disadvantage of buying the component from outside (See 1 above.)
Cash inflow from an alternative use of Division A's facilities
Advantage of buying 1,000 components from outside source

($15,000)
$18,000
$3,000

3. Assume that there are no alternative uses for Division A's internal facilities and
that the price from outsiders drops $20. Should Division C purchase from external
suppliers? What should the transfer price for the component be set at so that
division managers acting in their own divisions' best interests take actions that are
also in the best interest of the company as a whole?
Unit cost of buying the components from outside
Avoidable cost of manufacturing the components in Division A
Unit advantage of buying a component from outside
Total advantage of buying the 1,000 components from outside

($115)
$120
$5
$5,000

Transfer price:
Minimum that Division A (seller) would accept
Incremental costs of making component
Maximum that Division C (buyer) would pay

$120
$115

Since the maximum that Division C would pay is less than the minimum that Division A would
accept, no transfer should take place. Goal congruence would be achieved with a transfer
price set equal to the outside price of $115.
Problem 22-26 Transfer-pricing problem
Assume that Division A can sell the 1,000 units to other customers at $155 per unit, with variable
marketing costs of $5 per unit.
1. Determine whether Allison-Chambers will benefit if Division C purchases the 1,000
components from external suppliers at $135 per unit.
Unit cost of buying the component from outside
Avoidable cost of manufacturing the component in Division A
Unit disadvantage of buying the component from outside
Total disadvantage of buying the component from outside
Alternative use of facilities: 1,000 X ($155 - $120 - $5) =
Net benefit of Div. C buying outside at $135 & alternative sales by Div. A at $155

($135)
$120
($15)
($15,000)
$30,000
$15,000

Problem 22-28 Pertinent transfer price

Europa, Inc., has two Divisions, A and B, that manufacture expensive bicycles. Division A
produces the bicycle frame, and Division B assembles the rest of the bicycle onto the frame.
There is a market for both the subassembly and the final product. Each division has been
designated as a profit center. The transfer price for the subassembly has been set at the
long-run average market price. The following data are available for each division:
Selling price for final product (Division B's selling price)
Long-run average selling price for intermediate product
Incremental cost per unit for completion in Division B
Incremental cost per unit in Division A

$300
200
150
120

The manager of Division B has made the following calculation:

Europa
Division A
Produces Frame
Frame's Long-run Aver. SP
Incremental Costs

$200
$120

Division B
Assembles Bike
Final Selling Price
Mkt. Cost of Frame
Incremental Costs
CM Loss per Bike

$300
(200)
(150)
($50)

1. Should transfers be made to Division B if there is no unused capacity in Division A? Is the

long-run average market price the correct transfer price?
Unit Contribution margin from outside sales of frames (No transfers from Div. A to Div. B):
Frame's long-run average selling price
Incremental costs of producing frames
Unit CM from sale of frames in the intermediate market

$200
(120)
$80

Unit CM from transfer of frames to Division B accompanied by assembly and sale of bikes
Final selling price of assembled bikes
Incremental unit costs associated with Division A
Incremental unit costs associated with Division B
Unit contribution from sale of bikes

$300
(120)
(150)
$30

Unit CM loss resulting from transfers if there is no excess capacity in Division A

$50

The general guideline transfer price can be calculated as follows:

Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer

Minimum transfer price = $120 + ($200 - $120) = $200 which is the market price of frames
Use of this TP would result in a negative CM of $50 per unit transferred. Thus, no transfers would take place.
Final selling price of assembled bikes
General guideline unit transfer price associated with frames from Division A
Incremental unit costs associated with Division B
Unit contribution from sale of bikes given a transfer price of $200

$300
(200)
(150)
($50)

Division B must either drop the product or reduce the incremental costs of assembling bikes from $150 to less
than $100.
2. Assume that Division A's maximum capacity for this product is 1,000 units per month, and sales to the
intermediate market are now 800 units. Should 200 units be transferred to Division B? At what transfer
price? Division A will maintain the external $200 selling price indefinitely.
Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer
Minimum transfer price acceptable to Division A (seller) = $120 + 0 = $120.
Maximum transfer price acceptable to Division B (buyer) is $150. Any higher TP would result in a loss to Division B.

The company as a whole would profit by transferring regardless of the TP used:

For Example, assume a TP of $200 which is outside of the range of negotiation.

$200

Unit CM from transfer (sale) of frames from Div. A to Div. B:

Division A's selling price to Division B
Incremental costs of producing frames
Unit CM from transfer of frames from Div. A to Div. B (accrued in Div. A)

$200
(120)
$80

Unit CM from transfer of frames to Division B accompanied by assembly and sale of bikes
Final selling price of assembled bikes
Incremental unit costs associated with Division A
Incremental unit costs associated with Division B
Unit contribution from sale of bikes accrued in Div. B

$300
(200)
(150)
($50)

Overall unit contribution margin per unit transferred accrueing to the company

$30

Note: The following schedule summarizes the transfer prices for units transferred from A to B.
Profit to
Units
0 - 200
201 - 1,000

Transfer Price
$120 - $150
$200

Minimum TP = $120 + $0 = $120

Maximum TP = $150

Div. B
Div. A

TP = $120 + ($200 - $120) = $200

No Transfer

3. Suppose Division A quoted a transfer price of $150 for up to 200 units. What would be the CM
to the company as a whole if a transfer were made? As a manager of Division B, would you be
inclined to buy at $150?
Unit Contribution margin from transfer (sales) of frames from Div. A to Div. B:
Division A's selling price to Division B
Incremental costs of producing frames
Unit CM from transfer (sale) of frames from Div. A to Div. B

$150
(120)
$30

Unit CM from transfer of frames to Division B accompanied by assembly and sale of bikes
Final selling price of assembled bikes
Transfer price per unit transferred from Division A to Division B
Incremental unit costs associated with Division B
Unit contribution from sale of bikes

$300
(150)
(150)
$0

Overall unit contribution margin per unit transferred

$30

Since all of the CM generated from the transfers is allocated to Division A, there is little incentive
for Division manager B to buy from A.
Note: The transfer price that may appear optimal in an economic analysis, may in fact, be totally
unacceptable from the viewpoints of (1) preserving autonomy of the managers, and (2) evaluating
the performance of divisions as economic units. Transfer prices allocate contribution among divisions.

Problem 22-29 Pricing in imperfect markets

1. Suppose the manager of Division A has the option of (a) cutting the external price to $195, with
the certainty that sales will rise to 1,000 units, or (b) maintaining the external price of $200 for
the 800 units and transferring the 200 units to Division B at a price that would produce the same
operating income for Division A. What transfer price would produce the same operating income
for Division A? Is that price consistent with that recommended by the general guideline in the
chapter so that the resulting decision would be desirable for the company as a whole?
Solution approach #1:
Potential CM from external intermediate sale: 1,000 X ($195 - $120) =
Potential CM if SP is keep at $200 with sales volume of 800 units: 800 X ($200 - $120) =
Total CM that needs to be generated by the remaining 200 units
Remaining units
CM per unit that needs to be generated by each of the remaining 200 units
Incremental costs per unit to produce bicycle frames in Division A
Appropriate transfer price necessary to generate $11,000 of CM

$75,000
$64,000
$11,000
200
$55
120
$175

Solution approach #2:

Let X equal the transfer price at which Division A is indifferent between selling all units outside versus
transferring 200 units inside.
1,000 X $195 = (800 x $200) + 200 X
$195,000 = $160,000 + 200X
$35,000 = 200X
$35,000/200 = X
$175 = X
Solution approach #3:
Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer
Minimum transfer price = $120 + ($11,000/200) = $120 + $55 = $175

2. Suppose that if the selling price for the intermediate product is dropped to $195, sales to external parties
could be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer price is
acceptable. For simplicity, assume that there is no external market for the final 100 units of Division A's
capacity.
a. Using the general guideline, what is (are) the minimum transfer price(s) that should lead to the
correct economic decision? Ignore performance-evaluation considerations.
If 900 units are sold by Division A at $195:
Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer
Minimum transfer price = $120 + ($0) = $120 for the 100 units remaining

Thus TP for 1 - 100 units should be set at $120

If more than 100 units are needed:

Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer

$67,500
$64,000
$3,500

Must switch from 900 X ($195 - $120) =

To 800 X ($200 - $120) =
Contribution margin that must be covered by 2nd 100 units transferred
Minimum transfer price = $120 + ($3,500/100) = $120 + $35 = $155

Thus TP for 101 - 200 units should be set at $155

Division B would reject this because TP of $155 would make Bikes unprofitable ($300 - $155 - $150 = $(5)
even though it would be profitable to company as a whole but not as profitable as transferring only 100.
If more than 200 units need to be transferred then
Minimum transfer price = Additional unit incremental costs up to point of transfer + Unit opportunity cost of making the transfer
Minimum transfer price = $120 + ($200 - $120) = $200

b. Compare the total contribution under the alternatives to show why the transfer price(s) recommended
lead(s) to the optimal economic decision.
Options:
900 X ($195 - $120)

Transfer none

900 X ($195 - $120)

100 X ($300 - $120 - $150)
800 X ($200 - $120)
200 X ($300 - $120 - $150) =
Total Contribution

Transfer 100

Transfer 200

$67,500
$67,500
$3,000

$67,500

$70,500

$64,000
$6,000
$70,000

making the transfer

would take place.

rom $150 to less

sales to the
what transfer

making the transfer

See Q3

ing the transfer

xternal parties
ansfer price is
of Division A's

making the transfer

making the transfer

- $150 = $(5)

making the transfer

recommended

Problem 22-36 Transfer pricing, utilization of capacity

The California Instrument Company (CIC) consists of the semiconductor division and the process-control division, ea
operates as an independent profit center. The semiconductor division employs craftsmen who produce two different
components: the new high-performance Super-chip and an older product called Okay-chip. These two products have
cost characteristics:
California Instrument Company
Semiconductor Division
(Independent Profit Center)
Production:
Direct Materials
Direct Mfg. Labor
Hours
Labor rate/hour
Total
Total Direct Mfg. Costs
Capacity in Direct Labor Hrs.
Sales:
Super-Chip Customer
Maximum Demand @ $80
Selling Price
Okay-Chip Customers
Maximum Demand @ $26
Selling Price

Super-Chip Okay-Chip
$5
$2
3
$20
$60
$65

1
$20
$20
$22
45,000

15,000
$80
Unlimited
$26

Joint Research Project Revealed that:

(1) a single Super-Chip could be substituted for the circuit board used to produce the process-control unit
(2) the improved process-control unit could be sold for $145.

1. Calculate the CM per DL hour of selling Super-Chips and Okay-Chips. If no transfers of Super-Chips were made to
Process-Control Division, how many Super-Chips and Okay-Chips should the Semiconductor Division manufactur
What would be the division's annual contribution margin?
Super-Chip Okay-Chip
CM per DL hour
Selling Price
Variable Mfg. Costs
Contribution Margin per chip
Direct Mfg. Labor Hours Req.
CM per DL hour

$80
(65)
$15
3
$5

$26
(22)
$4
1
$4

Because the CM per DL hour is higher for Super-Chip than for Okay-Chip, CA Instrument Company should prod
and sell as many Super-Chips (15,000) as it can. Any remaining available capacity should be used to produce O
Chips. See below -- no capacity to produce any Okay-Chips.
Super-Chips:
Maximum Available DL Hours
Maximum Sales Potential
Okay-Chip
DL Hours Available for Okay-Chips
Hours required for Okay-Chips

15,000

45,000
(45,000)
0
1

Max. Production of Okay-Chips

CM/Chip
Maximum Potential Contribution

$15
$225,000

0
$4
$0

2. The Process-Control Division expects to sell 5,000 control units this year. From the viewpoint of CIC as a whole,
should 5,000 Super-chips be transferred to the Process-Control Division to replace circuit boards?
Benefit of Transfer to Process-Control Division:
Cost savings from external circuit board not needed
Cost of Super-Chip transferred to PCD
Cost savings per unit transfer to PCD
Extra revenue generated from improved PCU
New selling price
Old selling price
Extra unit contribution margin to PCD
Units to be transferred
Total Benefit to PCD
Disadvantage of Transfer to Semiconductor Division
Lost CM/unit per unit of Superchip transferred
Units of Super-Chip transferred to PCD
Net benefit to CIC of transferring 5,000 Super-Chips

$70
65
$5
$145
132

($15)
5,000

13
$18
5,000
$90,000

(75,000)
$15,000

3. What transfer price, or range of prices, would ensure goal congruence among the division managers?

Minimum TP per Super-Chip = Incremental cost per unit to pt. of transfer + opportunity cost lost per unit transferre
Minimum TP per Super-Chip = $65 + $15 = $80

However, if the manager of the Process-Control Division compares the $80 suggested TP with the outside purchas
price for circuit boards ($70), the transfer price will be wrongfully rejected.

The $80 TP should be compared with $83 which is determined by taking the outside price for the circuit board ($70
plus the contribution margin increase which could be lost if the transfer does not take place ($145-$132 or $13).

Note: the range of negotiation is from $80 (minimal acceptable amount to the Semiconductor Division) to $83 (ma
amount acceptable to the Process-Control Division).
4. If labor capacity in the semiconductor division were 60,000 hours instead of 45,000, would your answer to
requirement 3 differ?
60,000
45,000
If the external selling price of Super-Chips is held tight at $80, then the extra hours could be used to either
1. Produce Okay-Chips for outside sales, or
2. Produce Super-Chips for transfer to the Process-Control Division
Option 1: Produce & Sell 15,000 Okay-Chips & Sell 5,000 Regular PCU
Extra hours available
Hours required per unit produced
Extra units which can be produced
Produce & Sell Okay-Chips
Sales of 15,000 Okay- chips
Variable Mfg. Costs of Okay-chips
Contribution margin from Okay-chips

15,000
1
15,000

$26
(22)
$4

390,000
(330,000)
$60,000

Sales of Normal Process-Control Unit

Sales of 5,000 Regular PCUs
Outside cost of circuit board
Direct Mfg. Labor
Contribution margin from regular PCUs

$132
(70)
(45)
$17

Total CM Option #1

$660,000
(350,000)
(225,000)
$85,000
$145,000

Option 2: Produce Super-Chip & Transfer to PCD

Extra hours available
Hours required per unit produced
Extra units which can be produced

15,000
3
5,000

Sales of improved Process-Control Unit

Var. Mfg. Costs within Semiconductor Div.
Labor costs within Process-Control Division
Contribution margin Improved PCU

$145
(65)
(45)
$35

Benefit of Option 2
Incremental Approach:
SP Gain
Cost Savings
Extra CM from Improved PCU
CM from Okay-chips lost
Benefit of transfer

$725,000
(325,000)
(225,000)
$175,000
$30,000

$145
$70

$132
$65

$65,000
25,000
$90,000
(60,000)
$30,000

Minimum TP per Super-Chip = Incremental cost per unit to pt. of transfer + opportunity cost lost per unit transferre
Minimum TP per Super-Chip = $65 + ($60,000/5,000) = $65 + $12 = $77

Note the range of negotiation is from $77 (minimal acceptable amount to the Semiconductor Division) to $83 (maxi
amount acceptable to the Process-Control Division).
Proof: Transfer 5,000 Super-Chips to produce an Improved Process-Control Unit

Sales of improved PCU

Sales price (TP) of Super-Chip
Less incremental production costs
Cost per unit of Super-Chip
Labor costs within PCD

Sales of improved PCU

Sales price (TP) of Super-Chip
Less incremental production costs
Cost per unit of Super-Chip

Transfer @ $77
SD
PCD
$145
$725,000
$77
$385,000
($385,000)
($65) ($325,000)
($45)
$60,000

($225,000)
$115,000

Transfer @ $83
SD
PCD
$145
$725,000
$83
$415,000
($415,000)
($65) ($325,000)

Labor costs within PCD

($45)
$90,000

($225,000)
$85,000

Note: The solution manual has the following answer for the transfer price range.

"If 15,000 additional labor hours were available in the Semiconductor Division, those hours could be used to m
15,000 Okay-chips (at 1 labor hour per chip), or be used to manufacture 5,000 Super-chips (at 3 labor hours per
transfer to the Process-control Division. The Semiconductor Division manager would require a transfer price a
equal to the opportunity cost of the lost sales of Okay-chips. Because the Semiconductor Division could manu
and sell three Okay-chips at $26 each for every one Super-chip transferred, the minimum required transfer pric
$78 (3 X $26). The maximum price would remain at $83."
Can you determine why the answer book solution is in error? Hint: $66 not $65.
Hidden rows

or division and the process-control division, each of which

employs craftsmen who produce two different electronic
duct called Okay-chip. These two products have the following

rument Company
Process-Control Division
(Independent Profit Center)
Process-Control
Unit
$70

Production:
Direct Materials (Circuit Board)
Direct Mfg. Labor
Hours
Labor rate/hour
Total
Total Direct Mfg. Costs

3
$15
$45
$115

Sales:
Process-Control Unit
Quantity
Selling Price

?
$132
66

oard used to produce the process-control unit

$145

ps. If no transfers of Super-Chips were made to the

should the Semiconductor Division manufacture and sell?

Okay-Chip, CA Instrument Company should produce

g available capacity should be used to produce Okay-

s year. From the viewpoint of CIC as a whole,

vision to replace circuit boards?

nce among the division managers?

ansfer + opportunity cost lost per unit transferred

the $80 suggested TP with the outside purchase

aking the outside price for the circuit board ($70)

nsfer does not take place ($145-$132 or $13).
$83
ount to the Semiconductor Division) to $83 (maximum

nstead of 45,000, would your answer to

the extra hours could be used to either

ansfer + opportunity cost lost per unit transferred

unt to the Semiconductor Division) to $83 (maximum

s-Control Unit

$175,000

$175,000

nsfer price range.

ductor Division, those hours could be used to manufacture

ufacture 5,000 Super-chips (at 3 labor hours per chip) for
ivision manager would require a transfer price at least
ecause the Semiconductor Division could manufacture
transferred, the minimum required transfer price would be

Hint: $66 not $65.

Problem 22-17
Responsibility Center: Part, segment, or subunit of an organization whose manager is accountable for a
specified set of activities.
Cost Center: Responsibility center where the manager is accountable for costs only.
Revenue Center: Responsibility center where the manager is accountable for revenues only.
Profit Center: Responsibility center where the manager is accountable for revenues and costs.
Investment Center: Responsibility center where the manager is accountable for investments, revenues and costs.
1. Are the manufacturing plants in the Manufacturing Division cost centers or profit centers? Explain.
The manufacturing plants in the Manufacturing Division are cost centers.
Senior management determines the mfg. schedule based on the quantity of each type of lighting product specified
by the sales and marketing division and detailed studies of the time and cost to manufacture each type of product.
Manufacturing managers are accountable only for costs. They are evaluated based on achieving target output
within budgeted costs.
2. Quinn Corporation is considering decentralizing its marketing and manufacturing decisions by letting
manufacturing and marketing managers directly negotiate the prices for manufacturing various products.
a. How should Quinn evaluate manufacturing plant managers under this proposal?
If manufacturing and marketing managers were to directly negotiate the prices for manufacturing various
products, Quinn should evaluate manufacturing plant managers as profit centers. Profit would be determined as
revenues earned from marketing minus the costs incurred to produce and sell output.
b. Would you recommend that Quinn Corporation decentralize its marketing and manufacturing decisions?
Yes. Then each division could be evaluated as a profit center.
Decentralization should encourage plant managers to increase total output to achieve the greatest profitability,
and to cut their costs to increase margins.
Manufacturing managers should be motivated to design their operations according to the criteria that meet the
marketing managers' approval, thereby improving cooperation between manufacturing and marketing.

Under Quinn's existing system, manufacturing managers had every incentive not to improve. Manufacturing managers
incentives were to get as high a cost target as possible so that they could produce output within budgeted costs.
Any significant improvements could result in the target costs being lowered for the next year, increasing the
possibility of not achieving revised budgeted costs.
By the same line of reasoning, manufacturing managers would also try to limit their production so that production
quotas would not be increased in the future. Decentralizing manufacturing and marketing decisions overcomes
these problems.

ger is accountable for a

s and costs.

vestments, revenues and costs.

ofit centers? Explain.

pe of lighting product specified

nufacture each type of product.
on achieving target output

ing decisions by letting

ufacturing various products.

or manufacturing various
s. Profit would be determined as

and manufacturing decisions?

chieve the greatest profitability,

ng to the criteria that meet the

cturing and marketing.

t to improve. Manufacturing managers'

ce output within budgeted costs.
he next year, increasing the

heir production so that production

marketing decisions overcomes